The Equity of the Crowds

Crowdfund Act Passes In the Senate, But What Will It Mean for Startups?

crowdfund Crowdfund Act Passes In the Senate, But What Will It Mean for Startups?

Some familiar faces among AngelList's petition to pass the JOBS Act. (via angel.co/jobs-act/thank-you)

Update: On March 27th, the House passed a reconciled version of the JOBS Act, which includes the provisions from the Senate’s CROWDFUND Act, detailed below.

This afternoon, the Senate passed the Crowdfund Act by a resounding 73-26 vote. If you’ve been following the JOBS Act, which has won support from venture capitalists and founders alike (for evidence, just scroll down to this petition’s list of supporters), the Crowdfund Act is the Senate’s version of the JOBS bill, which now includes the requirement that startups looking to raise capital do so from SEC-approved websites.

The JOBS Act, short for  Jumpstart Our Business Startups, centered around rolling back some investor protections in the name of making it easier for small businesses to raise capital.

Although the JOBS bill passed in the House in a 390-23 vote a couple weeks ago, because legislators were successful in amending a number of “more stringent safeguards for investors,” the Crowdfunding Act will need to be reconciled with the JOBS Act and head back to the House, rather than to President Obama for approval, reports Politico.

The debate surrounding the legislation was whether rolling back protections would lead to fraud. The tech community overwhelming argued that regulations such as the 500-shareholder, being able to publicly discuss raising funds, and using crowd-funding platforms were holding them back. The amendments in the Crowdfund Act are designed to protect non-accredited investors, or as TechCrunch calls ‘em, “Your Mom.”

If it passes in the House, what will it mean for startups?

On Fortune.com, Dan Primack has a nice breakdown of the relevant changes to existing SEC regulations:

Shareholder Rule

Currently, once you hit the 500 shareholder cap, companies have to make their financials public. This bill would increase the threshold to 2,000 shareholders, which Mr. Primack calls an improvement, but “just as arbitrary.”

Crowdfunding Platforms

Mr. Primack calls this the “Kickstarter-for-equity provision,” which would enable platforms like WeFunder, which has been waiting for Congressional approval, to let startups issue shares in exchange for equity.

“This basically is for companies that either are too small for traditional angel/VC funding, or companies that are unable to secure such capital. In other words, we’re probably talking about a proliferation of thousands of lousy companies. But if just one or two become the next Facebook, then the trade-off is worth it.”

Well, either that or the Enron of startups swindles money from regular folks and no one gets to write articles about how Silicon Valley “is the opposite of Goldman Sachs,” anymore.

As one commenter noted in our post about WeFunder, the concept opened up opportunities, but “It sounds like you forgo the control that comes with a larger individual investment, as well as those juicy preferred dividends that come with many Series A investments (great news for the startup though!!).”

General Solicitation

Currently, Regulation D prohibits issuers, which includes privates companies and some VC and private equity funds, from “general solicitation” of investors. The new bill says sayonara to that restriction although only accredited investors can participate in Regulation D offerings. On the one hand, it means you won’t have to wait for a leak to the press to find out that Chris Sacca is raising a new fund. On the other hand, take a look at the charges the SEC recently brought against Felix Investments to get a picture of how quickly things can turn into a boiler room scenario.

Reducing Costs of Going Public

Perhaps you’ve noticed that hot startups from Zynga to LinkedIn to Groupon and soon Facebook have gone public recently? Well Congress hasn’t. This provision is to address what Mr. Primack calls “the imaginary IPO crisis.” Thus to reduce the costs of going public, the bill proposes reducing investor protections, such as one that prohibits analysts at investment banks from offering pre-IPO research on their own clients. As Mr. Primack noted earlier:

“Going public is not supposed to be a cakewalk. We’ve already been through an IPO environment where all you needed was a clever URL and a fuzzy mascot, and the results weren’t pretty.”

Protection for Investors

One of the amendments to the bill that passed today will require companies raising up to $1 million to share their financials with prospective investors. The same amendment would prevent investors with less than $100,000 in annual income from putting more than 5 percent of their income into a crowdfunded security. You can thank Congress later, Mom.

Follow Nitasha Tiku on Twitter or via RSS. ntiku@observer.com